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Failure of the New Economics

Failure of the New Economics

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11/28/2012

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We have had frequent occasion to note the ambiguities,
inconsistencies, and contradictions that run through the
General Theory; but in Chapter 11, "The Marginal Effi-
ciency of Capital," they reach an even higher level than in
the chapters preceding.
We shall see, as we go on, that Keynes uses the phrase,
"marginal efficiency of capital," in so many different senses
that it becomes at last impossible to keep track of them. Let
us begin with his first formal definition:

The relation between the prospective yield of a capital as-
set and its supply price or replacement cost, i.e. the relation
between the prospective yield of one more unit of that type of
capital and the cost of producing that unit, furnishes us with
the marginal efficiency of capital of that type. More precisely,

I define the marginal efficiency of capital as being equal to
that rate of discount which would make the present value of
the series of annuities given by the returns expected from the
capital-asset during its life just equal to its supply price.

[My italics in this sentence.] This gives us the marginal effi-
ciencies of particular types of capital-assets. The greatest of
these marginal efficiencies can then be regarded as the mar-
ginal efficiency of capital in general.
The reader should note that the marginal efficiency of capi-
tal is here defined in terms of the expectation of yield and of
the current supply price of the capital-asset. It depends on
the rate of return expected to be obtainable on money if it
were invested in a newly produced asset. . . (pp. 135-136).

156

"THE MARGINAL EFFICIENCY OF CAPITAL" 157

Keynes then goes on to tell us that we can build up a
"schedule" of the marginal efficiency of capital which we
can call alternatively the investment demand-schedule, and
that "the rate o£ investment will be pushed to the point on
the investment demand-schedule where the marginal effi-
ciency o£ capital in general is equal to the market rate of
interest" (p. 136-137).
Keynes next asks how his own definition o£ capital is
related to common usage. "The Marginal Productivity or
Yield or Efficiency or Utility o£ Capital are familiar terms
which we have all frequently used" (p. 137). (Just why does
he adopt the vaguest of them?)
"It is not easy by searching the literature of economics,"
Keynes goes on, "to find a clear statement of what econo-
mists have usually intended by these terms. There are at
least three ambiguities to clear up" (pp. 137-138). It is
amusing to find Keynes, that father of so many ambiguities,
so persistently worried about the alleged ambiguities of
others.

There is, to begin with, the ambiguity whether we are con-
cerned with the increment of physical product per unit of
time due to the employment of one more physical unit of
capital, or with the increment of value due to the employment
of one more value unit of capital. The former involves diffi-
culties as to the definition of the physical unit of capital,
which I believe to be both insoluble and unnecessary. It is, of
course, possible to say that ten laborers will raise more wheat
from a given area when they are in a position to make use of
certain additional machines; but I know of no means of re-
ducing this to an intelligible arithmetical ratio which does
not bring in values (p. 138).

All this is entirely true. But it is strange coming from
the coiner and adopter of "wage-units." On Keynes's own
definition, as we have seen, these are measured in propor-
tion to remuneration; they are therefore not "real" units
or "employment" units, but units of money value. If, in
offering the above illustration, Keynes had remembered

158 THE FAILURE OF THE "NEW ECONOMICS"

that it is also possible to say that five skilled or efficient
laborers will raise as much wheat from a given area as ten
unskilled or inefficient laborers, he would also have seen
that there is no intelligible way of measuring "wage-units"
which does not bring in values. Why was Keynes so much
more acute in detecting the ambiguities of other writers
than in detecting his own?

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